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As part of the Jobs and Growth Tax Relief Reconciliation Act of 2003, the federal government provided $10 billion in temporary fiscal relief payments to states, the District of Columbia, and the U.S. commonwealths and territories (herein referred to as states). Generally, use of these funds is unrestricted in nature; the act authorizes funds to be used to "provide essential government services" and to "cover the costs... of complying with any federal intergovernmental mandate." These funds were intended to provide antirecession fiscal stimulus to the national economy and to help close state budget shortfalls due to the recession that began in March 2001. According to the National Conference of State Legislatures (NCSL), in February 36 states reported facing budget shortfalls with a cumulative budget gap of about $25.7 billion. This report responds to the February 13, 2004, request by the Chairman of the Senate Committee on the Budget to provide information to help Congress assess the use of the temporary state fiscal relief payments. Specifically, we are reporting (1) what is known about the potential impacts of unrestricted fiscal relief on the fiscal behavior of states, (2) how the temporary fiscal relief payments were distributed among the states relative to their fiscal circumstances, and (3) how state budget officials report these funds were used. The temporary fiscal relief payments reviewed in this report were designed to provide assistance to help state and local governments address cyclical deficits prompted by the recent economic downturn. These payments were not intended to address longer term structural fiscal challenges facing state governments, and accordingly our report does not address these issues.

Temporary state fiscal relief funds share common characteristics with similar programs enacted in the 1970s that provided unrestricted funds to state and local governments. Past analyses of these programs can provide insights into the potential impacts unrestricted funds can have on the fiscal behavior of state governments. Past studies have also shown that unrestricted federal funds are fungible and can be substituted for state funds, and the uses of such funds are difficult or impossible to track. One study suggested that states could come to rely on federal aid in order to close budget gaps during economic downturns instead of taking actions, such as setting aside budgetary reserves, to stabilize their own finances. We examined the distribution of fiscal relief funds under the Jobs and Growth Tax Relief Reconciliation Act of 2003 in terms of its timing relative to national economic trends and its targeting relative to each states' fiscal circumstances. From the perspective of the national economy, the first distribution of fiscal relief funds occurred about 19 months after the end of the recession. However, employment levels continued to decline and this was reflected in continuing fiscal stress facing many states during this period. The funds were not targeted to take into account significant differences among states in the impact of the recession, fiscal capacity, and cost of expenditure responsibilities. Rather, the funds were allocated to the states on a per capita basis, adjusted to provide for minimum payment amounts to smaller states. According to NCSL, in April 2004 states reported facing a cumulative budget gap of $720 million, down from $21.5 billion at the same time the previous year. In all of the states we contacted with the exception of New Mexico, budget officials indicated that they had used their own reserve funds, to varying degrees, to address budget shortfalls. States reported deploying fiscal relief funds in state fiscal year 2003, 2004, or planned to in future years. Many of the 12 states we contacted reported using the funds as general revenue available to support broad state purposes. The one-time federal fiscal relief funds were available to help close budget gaps and reduce the pressure for tax increases or spending cuts.